New Fed Chief, New Unemployment Approach

Fifteen months ago, Ben Bernanke, then chairman of the Federal Reserve, indicated that the central bank’s ultra-easy money policy—a near zero federal funds rate and massive monthly purchases of Treasuries and mortgage backed securities—would remain in place until the unemployment rate hit 6.5%. Now, with the jobless rate poised just two-tenths of a point above that and the Fed under new leadership, the central bank has a new game plan.

In a recent speech, Federal Reserve Chair Janet Yellen spoke passionately on the continued slackness in the labor market, even citing the difficult circumstances of particular individuals. Yellen’s comments on the experience of Vicki Lira of Chicago—stuck in a part-time job because she can’t find the full-time employment she wants—sounded more like a political stump speech than the usual analysis from Fed members. Despite, or perhaps because, of the apparent closeness to the 6.5% jobless target, Yellen emphasized the continued need for Fed involvement in boosting the economy. Why the shift? Is it a matter of different chairmen having different policies? Unlikely: Yellen and Bernanke were rarely out of sync when she served as his deputy at the Fed.

More than likely, it’s a matter of timing and changing circumstances. Traditionally, the unemployment rate has been the key indicator of slack. But as it has dropped from 10% to 6.7%, its reliability—at least as the sole indicator of the job market’s health—has fallen into doubt. Because the traditional, standard measure of unemployment does not count as unemployed either individuals who have become too discouraged to actively seek work or involuntary part-timers, such as Lira, it can underestimate the relative scarcity of jobs compared with the number of would-be workers.

An alternative measurement, called U-6 by the Bureau of Labor Statistics, includes not only the unemployed who are actively pounding the pavement, but also discouraged former workers and involuntary part-timers. And that gauge of unemployment is much higher than the standard unemployment rate.

Bureau of Labor Statistics, Kiplinger

The standard unemployment rate does show some slack in the market; it’s still 2.2 percentage points higher than its prerecession low. But the alternative U-6 measure reveals a much looser labor market. The U-6 rate peaked much higher than the standard unemployment rate during the recession, and though it has dropped a good bit already, it is still 4.6 percentage points above its prerecession low point.

Other measuring sticks also indicate too few jobs for too many workers. Wages, for example, are growing very slowly; employees haven’t the muscle to insist on higher pay, and employers don’t need to bump wages up to attract more workers. Five years after the recession ended, annual wage growth will still be a modest 2% this year in nominal terms and much less after taking inflation into account.

Then there’s the labor force participation rate—the share of the population that is either working or actively seeking work. The labor force naturally changes over time as some workers retire, take time off to return to school, raise children or the like, and others seek employment for the first time or after a period of not working. It also waxes and wanes as those who are unemployed are encouraged or discouraged from actively seeking work by their perceived prospects of finding a job. In this particularly long, slow postrecession period, the labor force participation rate has fallen much further than expected, even given an anticipated bulge in baby boomer retirements. Reflecting, in part, a greater share of discouraged workers who are no longer job hunting, the rate has fallen from 66% before the recession to 63% today.

And the quit rate – the share of people who voluntarily leave one job to seek another, better one—remains low. The same today as it was during the recession, the low quit rate also signals slack—workers typically don’t risk abandoning one paycheck unless they’re sure of getting another.

Each of these measures points to a labor market that, despite the big decline in the standard unemployment rate, remains very weak. In March, private employment finally reclaimed its prerecession peak, but total employment still lags, and the share of jobs that are part time rather than full time is greater than normal.

What’s more, it will take several more years before the number of jobs in the U.S. catches up to the long-term trend—the number of jobs that would exist if there had been no recession and employment growth had continued to grow at a pace with population. At that pace, U.S. jobs would now total 146.8 million instead of the actual 141.3 million—a gap of about 5.5 million. (Because we want to focus on breadwinners, we’re including only jobs held by those age 20 and up.)

Bureau of Labor Statistics, Kiplinger

It takes roughly 1 million new jobs every year (83,000 a month) just to absorb new entrants to the labor market (immigrants as well as young first-timers). We expect a monthly average job gain of about 200,000 this year. At that pace, it will take until mid-2018 to make up for the shortfall.

Odds are that Yellen and her colleagues at the Fed will be uncomfortable pulling out all the monetary props until they are sure that the economy is well on its way to closing that gap and that something closer to the historical norm for the part-time/full-time divide is reached. Although the ongoing tapering of the Fed’s bond buying will continue, the federal funds rate isn’t likely to budge for many months yet—probably mid-2015 or so. Rest assured, Vicki Lira, the Fed has your back.